22 Jan 2014 12:00pm

Keep calm and read Schedule 36

For most practitioners, January is the month of the tax return deluge

In amongst the signed returns and sets of records with “I know this is late, but we will still meet the deadline, won’t we?” letters there are generally a few enquiry notices from HMRC.

Some will be easy to answer, but others will drag on through spring into summer and beyond. Where cases drag, HMRC is likely to issue an information notice and a particularly difficult case last year made me reflect on the way HMRC sometimes uses its powers.

The question at the heart of the case was the split of expenditure between repairs and capital. The figures were substantial because the property was substantial and in a very expensive location. The client still had all the paperwork he had needed to begin, monitor and conclude the project, but from his perspective what was important was returning the property to the letting market quickly and controlling cost and quality. He had evidence of all amounts expended showing the contractors, consultants and suppliers paid. If he’d read Section 12B of the Taxes Management Act 1970 he might even have thought he’d kept the records required by tax statute for his rental business.

I first learned about the project when we came to prepare his tax return. I explained the difference between capital and repairs and he apportioned the total. As he had owned the property for many years and had commissioned the work and watched it being undertaken he seemed the best qualified person to make the apportionment. We thought no more of it until, in late January, the enquiry letter appeared.

The inspector wanted to know how the apportionment had been made. We were asked for copies of all invoices, schedules of works, contracts, plans and various other documents.

Trying to assemble all of this paperwork into a form that would answer the inspector’s question was like trying to do a very large jigsaw puzzle with the picture facing down. It was a nightmare.

There was no final schedule of works. The schedule we had was the original one and while it was very detailed it did not help explain the variations or extras that accounted for over half of the final contract sum. The valuations did not always agree to the amounts invoiced and there were bills that were outside the contract.

Builders often use wording on documents with (understandably) no thought of tax consequences saying, for example, “new” when factually they should have said “replacement”. Once it is there in black and white it becomes a problem. Most of the suppliers were unwilling to help and the builders only had (or offered) very limited additional information.

I was trained to supply information as a complete package and not piecemeal (for good reason) but I have to confess that what I failed to do was tell the inspector that my client and I were tearing our hair out trying to assemble the jigsaw we had before us. Seeing only delay, the inspector responded by issuing a notice under Paragraph 1, Schedule 36 of Finance Act 2008. Paragraph 39 enables HMRC to issue an initial penalty of £300 for failure to supply information by the given date. That initial penalty can be the trigger for daily penalties.

At this point I explained the difficulties my client and I had been having. The inspector agreed an extension. This deferred the point at which a penalty could arise in accordance with Paragraph 44.

As the extended deadline approached however we still did not have sufficient pieces of the jigsaw to answer the question to the degree the inspector required. The threat of daily penalties was repeated and it simply added to the sense of helpless frustration: you cannot supply what you do not have. And that, thankfully, is what Schedule 36 says at Paragraph 18: “An information notice only requires a person to produce a document if it is in the person’s possession or power”. Penalties cannot apply if HMRC (or, on appeal, the tribunal) agrees that there is a reasonable excuse for the failure. I appealed on these grounds.

I also explained in detail the problems we faced and the very considerable work we had undertaken to try to answer the questions put to us. This included dozens of emails, letters and telephone calls to those who had carried out or supervised the work on the property and whose expert opinion would have been invaluable.

The inspector relented and again deferred the question of penalties pending provision of what information we had.

The conclusion of this story is for another day, but the key points thus far are:

• Encourage clients to tell you about their plans in advance: the records they think they will need and which they may regard as detailed may not be sufficient for tax purposes and if the necessary records aren’t created at the time, it may be impossible to create them after the event

• The client’s apportionment of expenditure - even based on clear guidance - may not be enough to convince HMRC without detailed supporting evidence

• Encourage clients to take before and after photographs of assets under repair or reconstruction and to put you in touch with surveyors and builders before the work starts so that they can highlight key details in the documents they produce; explain how careful they need to be with words like “new”

• If you have difficulty in assembling or providing information, tell HMRC straight away and keep the inspector informed; don’t keep the frustration to yourself

• If you are faced with the cosh of penalties for failing to comply with an information notice, ask yourself if the information is reasonably required and if it is in your or your client’s possession or power

• Have a look at HMRC’s Compliance Handbook and read the guidance given to inspectors in the application of the Schedule 36 powers

To be continued....


Paul AplinPaul Aplin is a tax partner with A C Mole & Sons and chairman of the ICAEW Tax Faculty Technical Committee; you can follow him on Twitter: @PaulAplinOnTax


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